The Gas Conflict between Russia and Ukraine

On January 1, 2009, Gazprom cut off natural gas deliveries to Ukraine claiming that it had failed to pay for gas deliveries in 2008 and for the penalties exacted from these delayed payments, and because no agreement had been reached on the price for deliveries in 2009. After Ukraine began charging gas as payment for its transit services, Prime Minister Putin ordered drastic cuts.

Gazprom's action was no surprise. Top Russian officials had given loud warnings and Gazprom has repeatedly cut off its gas deliveries to all its post-Soviet customers: Estonia, Latvia, Lithuania, Belarus, Ukraine, Moldova, Georgia, Azerbaijan, and Armenia. Ukraine faced the same fate three years ago. Gazprom is notorious for its aggressive, monopoly pricing and for disrespecting its customers.

How can the European Union tolerate a corrupt intermediary such as RosUkrEnergo gambling with Europe’s energy security?

Yet it is amazing that Gazprom could treat Ukraine, one of its largest customers, like this. By December 30, Ukraine had paid for all the gas it had imported in 2008. In spite of Ukraine's prepayment, Gazprom claimed penalties first of $450 million and now of $614 million without any public explanation. On Christmas, before the negotiations had failed, Gazprom even opened a website abusing Ukraine.

The commercial dispute is rather elementary. Prime Minister Vladimir Putin has publicly offered Ukraine a gas price of $250 per 1,000 cubic meters, while in a joint statement on January 1, President Viktor Yushchenko and Prime Minister Yuliya Tymoshenko argued for a price of $201 per 1,000 cubic meters, in comparison with $179.50 in 2008. Another dispute concerns the transit tariff Gazprom pays Ukraine for its deliveries to Europe. Currently, this is $1.70 per 100 km per 1,000 cubic meters, but Ukraine wants to raise it to at least $2.

The commercial differences are small, and an agreement should be possible. Ukrainian Deputy Prime Minister Oleh Dubyna has been quoted as accepting a gas price of $235 and a transit tariff of $1.80.

On October 2, 2008, Putin and Tymoshenko signed a memorandum of understanding on Russian-Ukrainian gas relations. Over the course of three years, Ukraine would gradually move to West European prices, paying 50 percent of them in 2009, 75 percent in 2010, and 100 percent in 2011. Since the European price is $418 at present, both parties were in the same ballpark.

But Russia's abrupt disruption of all gas supplies to Ukraine when an agreement was so close suggests that the reasons for this action are not strictly commercial. The vehement comments against Ukraine by top Russian officials, notably Prime Minister Putin, reinforce these suspicions.

A political explanation is that the Kremlin wants to destabilize Ukraine, showing how bad democracy is for Eastern Slavs, while arousing Russians to a patriotic cause: “The Ukrainians must pay us!” Russia has been badly hit by the international financial crisis, but the only source of legitimacy for Putin's authoritarian government is high economic growth. Putin has become notorious for provoking fights with independent, democratic neighbors, such as Georgia, Ukraine, and Estonia for apparently domestic reasons.

Another explanation is that the Kremlin wants to maintain RosUkrEnergo, the nontransparent trading intermediary that sells Turkmen gas to Ukraine through Gazprom's pipelines. UkrGaz-Energo, its joint venture with the Ukrainian state gas company Naftohaz, controls the profitable part of Ukraine's domestic sales of gas. RosUkrEnergo is owned by Gazprombank, a mysterious, privatized bank related to Gazprom, and two Ukrainian businessmen, one of whom is Dmytro Firtash, a major source of financing for former Prime Minister Viktor Yanukovych's Regions party.

RosUkrEnergo is important to the Kremlin, providing some high Russian officials with substantial personal revenues and financing much of Ukrainian politics. Prime Minister Tymoshenko has campaigned for the exclusion of RosUkrEnergo. She has largely managed to oust it from the domestic Ukrainian market, and on October 2, 2008, she and Putin agreed to eliminate RosUkrEnergo from the Russian-Ukrainian gas trade as well. In fact, Ukraine has no direct financial relations with Gazprom, rendering the company's complaint that Ukraine owed it money absurd.

Ukraine's commercial interests are substantial. Its acceptance of a low fixed transit tariff of January 2006 makes little sense, since Russia has not guaranteed gas prices. With falling prices and reduced demand for natural gas due to the global economic slowdown, Ukraine is likely to get a lower price later on. Because of its precarious financial situation, it needs to cut its gas consumption drastically. The country has a strong negotiating position, since 80 percent of Russia's gas exports to Europe travel through Ukraine and no substantial alternative will be available for years. Moreover, its reserves are sufficient for three months of domestic consumption.

Gazprom's neglect of its European customers is all the more perplexing. Gazprom's main customers, having already experienced the company's unreliability, have built up buffer stocks of three months. Gazprom's production fell by a whopping 10.6 percent in November 2008 over November 2007 because its Central European customers cut purchases from its most unreliable and expensive supplier. Gazprom behaves as if it had a monopoly over the EU market; fortunately it does not.

Most amazing is the European Union's passivity, despite the fact that it receives 20 percent of its total gas supplies through Ukraine. How can the European Union tolerate a corrupt intermediary such as RosUkrEnergo gambling with Europe's energy security? The European Union cannot act like a frail victim. It needs to assume the role of an energetic mediator to solve the Russian-Ukrainian gas conflict and finally adopt an energy policy.